Deflationary Debt Destruction Must Run Its Course

Not until then will there be the hyper-inflationary event most are looking for.

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My vacation back to the US surprised and confounded many of my old friends: they know I moved back to park my wealth in dollars. Incredulously they asked how I could possibly not believe the US government, along with their crony partner the Federal Reserve, will not devalue the dollar to "settle" our debt with foreign lenders. A normal default (since we all know there is no way to possibly pay this debt back, nor is their enough capital in the world to buy our newly needed "financings") isn't palatable, they say, so the only direction for the dollar is down.

I agree, but only in the long run. In the short run it is more nuanced, as illustrated by the recent meeting between Chinese and US officials (berries).

Secretary of State Hillary Clinton characterized the meeting as one making our Chinese lenders more "comfortable" with their lending, that they are soothed by our handling of the financial crisis (whatever that is) and this should allay our fears that China will lend less at a higher cost to us.

First of all I hope it is not lost on everyone that having a communist country "comfortable" in how we are conducting finance is not a good thing. A communist country that probably has some very sinister ideas of what they really want out of us. The fact that a very few people are making vast decisions for this country is only something the Chinese can understand and condone because they are not concerned with liberty. It certainly is not something that should make the rest of us who do care about it (hopefully) feel "comfortable".

I have a more complex opinion of the conversation between the berries than that of Ms. Clinton. If the Chinese felt that we would immediately and imminently devalue the dollar (by a vast monetization), they would immediately dump their vast horde of them. So something occurred at the meeting that assuaged the Chinese (at least temporarily) from doing so, and I don't think we did most of the talking.

Yes the US has already executed some mini-monetizations (printing dollars to buy debt). In fact we just did a stair-stepped monetization to clear the last auction (more to come). Yes we have back-stopped vast assets of the banking system with taxpayer money. Yes the Fed and other government agencies (GNMA/FHA now account for nine out of ten new mortgages, mostly subprime, in the U.S. as reported by the WSJ today). But all this so far has merely gone to plug the holes of destroyed dollars, to "stabilize" the U.S. economy. So far it is not enough to further devalue the dollar. This is simply because there is so much debt in the system: Overall debt has actually increased over the last few months.

So whatever the Chinese said to get more "comfortable" would directly prevent massive dollar devaluation, at least for the time being. Most likely the Chinese berries coerced a promise to either raise taxes and/or cut spending at some point in the near future from our berries. Don't look for a generation of stimulus.

So the US berries, not knowing what they are doing in the first place, will at least try for some time to reduce the fiscal largesse they have unleashed on the economy. Most "hyper-inflationists" will say this will be impossible for them to do. I agree in the long run, but in the short run I think there is vast pressure to do so.

With the US government largess being the only thing supporting the US economy (or the impression of supporting the economy), any pullback at this point will greatly accelerate economic deterioration. There is vast debt in the banking system, held at the Fed, held at government agencies, and held by private investors that is still being carried at way too high of values. Everyone is holding their nose given the government backstop; without it the stink will come in through the ears.

Foreclosures, defaults, and delinquencies are being significantly under-reported even now as the government is supporting all of it and as regulatory bodies have allowed banks and other "investors" to over-value it. If that is decreased even one iota they will increase. As debt is destroyed the dollar will strengthen.

I think this will go on until stock prices hit new lows again and the government will abandon all sensibility. Not until then will be there be a hyper-inflationary event that most are looking for. It requires lower prices to spur lending to spur inflation. Hopefully by then my extended vacation in the US will have ended and I will be off to another place.

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